Why Does Book Building Drive Out Auction Methods of IPO Issuance? Evidence from Japan

Abstract

We examine Japan's 1997 introduction of book building as an alternative to an auction method of IPO issuance that had been required since 1989. Despite its higher total issue cost for some issuers, all issuers in Japan now select book building. In contrast to auctioning, book building enables firms to be valued more accurately. Because the gains from more accurate valuation are partly redistributive, book building can drive auction-method offerings from the market even if book building yields no aggregate benefit to issuers. Compared to Japan's prior auction regime, we find that for large, well-established issuers, book building reduces total issue cost. The auction regime is less costly for small issuers, but appears to foreclose some high-quality small firms from issuing. Although book building is more costly for small issuers, the aggregate costs of book building and auctioning in Japan are similar. Because cost estimates for auctioning do not reflect the effects of some firms not issuing and because book building yields other benefits associated with more-accurate valuation, the evidence from Japan's market experiment favors book building over auction.